I also thought that reconstitution arbitrage shows up as negative alpha in 3F regressions (as in the large negative alpha for the Russell 2000v index) which leads to lower returns than the factor loadings suggest. However if this effect is already reflected in the index – and the index itself is used to determine risk exposure (loadings) I am not sure this is the source of the difference – it may lie elsewhere (beta, or standard errors?). I don’t recall getting such a wide difference between actual ishares600v returns and that suggested from the Fama-French factor returns data (multiplied by the estimated factor loadings) – but will recheck.
(I may have misunderstood your comment here, but my comment is:)
Actually, this index constitution bias is
reflected in the returns of the Index/fund (such as Russell 2000 or S&P 600), but not the Benchmark factors used to calculate the 3F risk premiums -- the Fama French series.
The Citigroup Small Value series had a negative alpha of 0.16% per month. That was lower than the Russell 2000 Value (-.25%/month), and in line with the MSCI 1750 Small Value index. I hesitate to make too much of any of this, as only the r2K VL index had statistically significant
However if the core funds rebalance daily then the ‘momentum’ effect better captured in broader rebalancing bands used in a component portfolio may off-set the additional costs of rebalancing. [Doesn’t DFA use momentum screens in the core funds?].
Core's rebalance daily with new portfolio dollars. So, if there is $10M per day coming into US Core 2, that money theoretically will be used only to buy stocks in categories that have experienced migration (and contain less than ideal #/% of holdings).
I would imagine the momentum effect would be even larger in Cores because those migrating SV stocks maynot be sold until they become much, much bigger Large or Growth stocks....The newer, larger capitalization of the recently migrated company is accounted for by the fact that w/i TSM, it now commands a larger weighting in the portfolio, and in Small and Mid Cap and Value segments, Cores have a higher target % of that stock than TSM does...money may even have to be added to these stocks to account for market cap targets than can be as much as 3 to 5 times the TSM allocation -- but I have no idea if this actually happens. At the very least, I cannot imaging they are sold at all (which is why I say they are even more "momentum friendly").
In component funds/ETFs such as iShares or DFA, even with "buffer zones", micro and small value stocks must be sold completely by the time they reach "mid cap" or "blend" ranges. Their larger market caps and price/book values risk contaminating the lower cap and p/b targets of strict S/V funds -- but will be held almost in their entirety? within the Core structure.
I would also prefer a more consistent global value tilt but the last time I looked at this the return difference between an even value loading across the US and non-US and what I currently target was 0.2%
Boy, this is hard to quantify! I read that post you linked, even made a quick comment on it (I see
) My opinion would be that a consistent global small/value tilt maybe worth a bit more than 0.2%, but cannot be sure.
I am more used to modeling this stuff using the actual Fama/French Index series along with S&P 500 and EAFE for market exposure. I found, going back to 1975 (thru 2006), a US/Int'l portfolio that is 50% market, 25% LV, and 25% Small" both in the US and EAFE markets (P1)
had 0.9% a year higher risk adjusted returns vs. a US/Int'l portfolio that was split evenly between US LV and US Small for domestic, but 100% EAFE Market for foreign (P2)
The above example suffers from the fact that S&P had higher returns than EAFE for the period under question, and annualized MkT-LV and MkT-Small premiums were higher internationally than in the US.
The best I can do to remedy this is to observe the 1975-1999 period, where US LV and US Small annualized returns were almost identical to Int'l LV and Int'l Small results (but EAFE still trailed S&P by over 2% a year). During this period, P1 outpaced the risk adjusted return of P2 by about 1.2% annually.
(I made these portfolios risk neutral by adding 5% 1YR T-Notes to P2 in each example to make standard deviation identical)
Suffice it to say, different approaches to looking at the Global Factor allocation decision will reasonably come up with different measures of value. How much EM S/V adds to this is another discussion for another day.
And if DFA had TA vector funds for the US, Non-US developed, and EM I would seriously consider them. Although by having a higher size loading I may have to live with shortening my term exposure from 0.5 to about 0.2 to get a similar portfolio expected return...
Yikes, I cannot imagine you hiring an advisor for DFA access...and based on what you have written here the last few months -- that would seem about the only reason for you to do it. I am of the opinion that you are smarter than the average "low cost-advisor" you would likely be looking to for DFA access, the exception of course being Equius's new low cost venture.
As for your above-proposed fixed income decision, I have to hand it to you Robert, you are a lot more precise than I am!
I am too lazy to even consider why that would be the case
Keep up the great research, they are great bookmarks to go back to from time to time. I wish there were a better place to discuss almost exclusively Multifactor Investing -- a place that doesn't get bogged down in DFA vs. Vanguard vs. iShare debates.